Caixin
Jul 20, 2016 02:54 PM

State Council Gives Green Light for Debt-to-Equity Swap Trials

(Beijing) – The government has signaled that it is pushing forward with a program to allow debt-to-equity swaps as part of a strategy to deal with trillions of yuan of corporate loans at risk of turning sour.

The State Council, China's cabinet, released a policy, published in full by the official Xinhua News Agency on July 18, which says financial institutions will be allowed to hold equity in enterprises on a trial basis.

The announcement didn't give a timetable, but experts say it marks the official launch of pilot programs that will finally allow banks to exchange overdue loans for equity in the companies who owe the money.

Premier Li Keqiang in March highlighted debt-to-equity swaps as a key plank of the government's strategy to defuse risks in the financial system. The scheme is seen as a win-win by the government – it will rein in banks' bad debts and non-performing loan ratios, while lowering companies' leverage ratios and easing their debt repayment burden.

But the program has been slow to get off the ground, partly because of reluctance by the banks themselves to participate and partly because under current legislation, lenders are prohibited from using their own capital to buy shares in companies unless they have special approval from the government.

The first batch of swaps will involve the transfer of 1 trillion yuan worth of bank loans into equity, an executive from the China Development Bank (CDB), one of the country's three policy lenders, told Caixin in April.

CDB is among the financial institutions expected to participate in the first round, sources told Caixin. Others include Bank of China, Industrial and Commercial Bank of China, China Minsheng Bank, the Export-Import Bank of China, and China Merchants Bank.

The combined non-performing loan ratio of commercial banks rose to 1.81 percent at the end of June from 1.75 percent at the end of March, data from the China Banking Regulatory Commission show. That's the highest since the global financial crisis, when NPL ratios reached a record 2.04 percent at the end of March 2009.

A report from the International Monetary Fund in April estimated that China's commercial banks had loans "potentially at risk" amounting to 15.5% of total lending, or US$1.3 trillion.

A pilot program allowing banks to take equity stakes in high-tech startups is also underway as part of the government's strategy to boost financial support to emerging sectors. In April, 10 banks were chosen for the pilot program, and they each set up a subsidiary for making equity investment to ensure they complied with the law.

(Rewritten by Wang Yuqian)

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